Banking

The risks and costs of climate change for banks

May 19, 2021

RESEARCH REPORT

In brief

As climate change wreaks its environmental havoc it also is inflicting vast costs—in the trillions of dollars—on states, businesses and individuals.
These costs arise not only from the risk of actual physical damage but also the transition to reduced carbon use.
Four key steps will help banks build the economic risks of climate change into their overall risk management strategy.

Climate change is wreaking havoc around the globe, resulting in vast costs. According to our report on financial risks tied to climate change, rising sea levels and greater storm surges alone are expected to cost coastal urban areas over US$1 trillion each year by 2050. Costs associated with addressing climate change—such as meeting Paris Agreement goals—are expected to be in the trillions of dollars.

Clearly, mitigating the effects of climate change is both an environmental and an economic concern, exposing businesses to significant financial and non-financial risks.

Quantifying the risk

Transitioning to a low-carbon economy represents a dramatic shift. According to one analysis, we would need to leave as much as a third of the world’s current oil reserves, half of its gas reserves and more than 80 percent of coal reserves unused between 2010 and 2050 to limit the man-made temperature increase to only two degrees Celsius. Here’s a look at what this would mean.

95%

Almost all electricity would need to be low-carbon.

70%

Currently only 1% of cars are electric. This would have to shift to 70%.

80%

Industrial CO2 emissions would need to drop by 80%.

Rethinking the risk lexicon

Banks should prepare to be on top of this dramatic shift. They should anticipate the risks associated with transitioning to a low-carbon economy, and time their responses appropriately.

Here is a snapshot of climate-related risks—related both to physical challenges and concerns around economic transition—for a variety of standard risk categories:

Credit risk: Increased floods bring risk to a bank’s mortgage portfolio (physical); higher energy efficiency standards impact property exposures (transitional)
Market risk: Severe weather events lead to re-pricing of sovereign debts (physical); stricter climate policies result in re-pricing of securities and derivatives (transitional)
Operational risk: Severe weather events impact business continuity (physical); evolving sentiment around climate change leads to reputational exposure (transitional)

Regulators expect action

Regulators and central banks already expect financial firms to demonstrate they are effectively managing the risks related to climate change.

And while banks are responding, they may need to quicken the pace. A Prudential Regulation Authority (PRA) survey found that while a majority of banks have begun addressing climate risks as financial risks, those which they anticipate tend to be pushed beyond their typical four-year planning horizon.

Banks and regulators may benefit from teaming together to recalibrate capital and risk models so they align better with climate change and the related mitigation policies. To get there, banks should develop a nuanced understanding of their balance sheet exposure to climate-related risks. Regulators, for their part, should promote greater clarity around the treatment of environmental exposures.

The PRA published a Supervisory Statement (SS3/19) to enhance and align banks' and insurers' approaches to managing the financial risks of climate change.

It emphasized firms should adopt a strategic response to the unique challenges arising from climate change
It advised them to incorporate climate risks into their risk management frameworks, policies and procedures
It encouraged them to build risk into key management information to support effective monitoring, management and oversight

Retooling the bank for sustainable lending

Facing the climate challenge

What can banks do to prepare for the dynamic, multi-faceted risks associated with climate change? Our report suggests these four steps:

Adjust risk appetite

Climate risks should be incorporated into the existing risk taxonomy, rather than a new, separate climate risk category.

Create a climate risk register

A point-in-time view of a bank’s climate risk exposure serves as a basis for an ongoing review to find risks that need active monitoring.

Conduct framework gap analysis

Based on the relevant climate risk register, banks should assess the maturity of their climate risk management.

Quantify and measure climate risks

Banks can build tools to support active risk management and scenario analysis.

Managing the economic risks of climate change should become central to banks' overall risk management strategy. Banks can get there by incorporating climate decisions into product innovation, capital management, business planning and strategic transactions.

Accenture is poised to help clients understand and respond to the risk implications of climate change. Please contact the authors to learn more.